I’ve touched on this before as regards higher education, but more needs to be said.
I mostly talk about higher education, but something’s been bugging me, and higher education is usually pretty quiet over the summer (which is why we don’t need legions of highly paid full time administrators, something the people paying for the schools should understand…).
First, a bit of history:
The Titanic hit the iceberg, and sank around 2 hours and 40 minutes later. After it hit the iceberg, the ship was doomed, but, being so large a ship, it still took hours to sink. After it hit the iceberg, I’m pretty sure, for many on board the ship, they thought they were going to be fine…this ship hadn’t sunk, didn’t appear to be sinking to the casual observer, thus all was well. The people who stayed in their staterooms would have noticed nothing but a big bump (the iceberg), then over two hours of nothing…then cold water suddenly rushing in as the doom of the Titanic arrives. The mathematics of the situation said that the ship would be fine for a while, then it would sink quickly.
And that’s what happened. I’m sure the gentle reader is asking “What does any of this have to do with pension funds?”
Pension funds struck their own iceberg in 2008. Yes, that was eight years ago, but pension funds, much like the Titanic, are huge things: there’s going to be a big lag between the fatal blow and the actual time of death.
Before I get to what happened, let me explain in simple terms how many pensions work, especially public pensions (which, in a country where the state/local/federal government combined is the largest employer, are huge).
First, the pension figures out how much to pay to the pensioner. Let’s call this $50,000 a year, for example.
Then, the pension figures out how much money they can safely make, using only safe investments (after expenses). Let’s call this a 5% return, even though many pensions figured they’d make more—realize expenses can easily consume a percent or two off the return.
So, the pension fund figures they need $50,000 a year, and to make 5% off of invested money. From this, the fund could put aside $1,000,000, because then the net interest income (5% of $1,000,000, or $50,000) would match the payments to the pensioner.
This is ridiculously conservative, however. Most pensions, especially our poorly managed public pensions, would put aside around $500,000. Yes, then they only make $25,000 in interest and have to make the difference up in principal, but that’s fine. It’ll take less than 20 years for the money to be all gone, but most pensioners live less than 20 years after retirement (and those that die early offset those that live “too long”). This admittedly is risky underfunding, but most public funds were/are underfunded like this.
So, in short, pensions put aside $500,000 to pay $50,000 in yearly benefits, assuming a 5% rate of return. In 20 years, the money put aside is long gone, but the pensioner is dead by then so it’s all good. Let’s just follow this for a few years. After 1 year, for example, $475,000 put aside. At the end of year 2, there’s still $448, 720 in the account. After year 3, there’s still $421,156. These are simple calculations for the folks that run pension funds, and they see it all coming from years away.
In 2008, an iceberg hit the financial markets and a glimmer of the immense fraud going on in high finance almost revealed itself. The Federal government rushed to save the big banks perpetrating the fraud, printing huge amounts of cash to cover the bank losses, and lowering interest rates to, well, basically nothing, greatly enhancing bank profits.
Much like with the Titanic, after the 2008 bump everything seemed fine…but the mathematics of the lowered interest rates (particularly the insane negative rates that are becoming common) will sink every pension fund, I promise you.
Instead of interest rates yielding a net 5% profit (keep in mind, the fund has expenses to pay, cutting into the yield of the invested money), now pension funds, if they want to invest safely, can only get around a net of 1% (humor me as I keep the numbers simple, although a fraction of a single percent is more accurate, and there are trillions of dollars in negative interest rate bonds, to give an idea how desperate for yield people are now).
Imagine that fund with $500,000 in 2008. In 2009, instead of dropping to $475,000 like before, there’s now only $455,000 in the account.
Now, one bad year is no big deal, pension funds play the long game, and they can make up the difference with just a slightly better yield in future years, say 5.2%. But the Fed has kept rates at near nothing for 8 years now. The “emergency measure” of making rates ridiculously low has wreaked havoc all through our financial system. It was supposed to be a single-year measure, but despite the government saying all is fine now, those rates have yet to creep up to normal in the last eight years.
One year isn’t too bad, but eight years? We have a problem. They’ve lost too much money, there’s not enough new money coming in (because the planned payments to the pension funds were set when safe rates were at 5%), and there is mathematically no way they can survive, without massively cutting benefits.
In 2010, that fund will have $450,500 instead of $475,000. By 2016, it’ll be $204,000 or so. The money is going to run out in less than five years after that. In the old model, most pensioners would die in 20 years…but now they need to die much more quickly. Anyone in this fund will get a nice check every year, as planned, no complaints at all, right up until there’s absolutely no money in the fund. Then they get nothing. I reckon there will be complaints then, yes?
Short of cataclysmic war killing lots of pensioners (don’t rule that out, alas), the numbers just won’t work here.
At this point, interest rates on safe investments need to shoot up around triple what they were before 2008, and stay that way for over a decade. A few years ago, “all” pension funds needed was a bit above 10% safe returns. When I was a stockbroker in the 80s, you could get CDs paying over 10%. Now pension funds need safe rates to get over 15% for a decade or more to possibly reverse the last 8 years of no-interest returns. This isn’t going to happen, no way, no how.
We’re already seeing the worst managed funds starting to die.
Two of Chicago’s four city pension funds will be bankrupt within a few years, according to Chicago Mayor Rahm Emanuel. You’d think that’s a scenario unions – the supposed champions for public-employee retirements – would want to avoid.
The funds have taken on too much water. Just about every fund is, simply, doomed, even if things look hunky-dory right now.
Phoenix is far from alone. Cities around the Grand Canyon state are experiencing pension “sticker shock,” in the words of the Arizona Republic. Six other cities—including Mesa, Scottsdale, and Glendale—face $23 million in extra pension payments next year. Thanks to poor stock market performance and an inability to reduce its pension benefits,
The worst managed funds are already in big trouble, as I link above and below. These are the worst managed, but every fund will be sinking soon.
More than a quarter of a million active and retired truckers and their families could soon see their pension benefits severely cut — even though their pension fund is still years away from running out of money.
…Already, three other pension plans that pay benefits to truck drivers and ironworkers have applied to the Treasury to have their pension benefits reduced…
–I point out that the accountants can see the bankruptcy coming from years away, but it is as inevitable as the sinking of the Titanic after it hit the iceberg.
The private funds will go belly-up, and they’ll either be allowed to fail (destroying huge numbers of families) or the Federal government will take over. The Fedgov will likely take over the public employee funds.
Now, when the Fed takes over, the first action they’ll take is to cut payments, and cut payments big time. 40% cuts will be typical, and hey, that’s still better than the 100% cuts that funds not taken over by the Fed will pay.
The only way funds can avoid doom is to cut benefits, steeply. Again, this is simple math, and reducing benefits like this is what we call “austerity.”
Hey, anyone seen those riots in Greece and other countries when “austerity” is practiced? We’ll be seeing that here, too, because once wide swaths of the population see their checks cut or removed completely, they’re going to riot, starve, or, most likely, both.
I know, there are many huge and obvious problems in America right now, and many people will simply hope for the best that this mathematical inevitability will not occur. I encourage the gentle reader to please, please, don’t count on your state or private retirement fund being there in a decade or two…at this point it’s as likely as the Titanic finally pulling into port.